Question

The Sweetwater Candy Company would like to buy a new machine that would automatically “dip” chocolates. The dipping operation currently is done largely by hand. The machine the company is considering costs $150,000. The manufacturer estimates that the machine would be usable for five years but would require the replacement of several key parts at the end of the third year. These parts would cost $9,600, including installation. After five years, the machine could be sold for $7,000.

The company estimates that the cost to operate the machine will be $7,600 per year. The present method of dipping chocolates costs $36,000 per year. In addition to reducing costs, the new machine will increase production by 8,000 boxes of chocolates per year. The company realizes a contribution margin of $1.15 per box. A 13% rate of return is required on all investments.

Click here to view Exhibit 13B-1 and Exhibit 13B-2, to determine the appropriate discount factor(s) using tables.

Required:

1. What are the annual net cash inflows that will be provided by the new dipping machine?

2. Compute the new machine’s net present value.

Answer 1

1
Reduction in annual operating costs:
Operating costs, present hand method	36000
Operating costs, new machine	7600
Annual savings in operating costs	28400
Increased annual contribution margin	9200	=8000*1.15
Total annual net cash inflows	37600
2
	Now	1	2	3	4	5
Purchase of machine	-150000
Annual net cash inflows		37600	37600	37600	37600	37600
Replacement of parts				-9600
Salvage value of the machine						7000
Total cash flows	-150000	37600	37600	28000	37600	44600
Discount factor (13%)	1	0.885	0.783	0.693	0.613	0.543
Present value	-150000	33276	29441	19404	23049	24218
Net present value	-20612